I’ve posted Entry #716 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called How Valuations Affect Long-Term Returns (and Why It’s a Big Deal).
Juicy Excerpt: As a nation of people, we pat Shiller on the head and praise him for doing good work. Then we go right back to investing as we did in the days before this amazing, Nobel-prize-winning research appeared on the scene. Irrational exuberance, irrational exuberance. We like big numbers on our stock portfolio. So what if the research shows that they will disappear in time? We like that thrill we experience for the time in which they remain big.
When we all come around to your way of thinking how long do you think it will take for PE10 to correct from mid 30s to 17 (your “fair value” figure)?
That’s a good question.
I am not able not give a clear, precise answer. It is a very big change in human psychology that we are talking about, the difference between believing that the numbers on our portfolio statement are real and that bull markets are good and understanding that only gains rooted in economic growth are good and that irrational exuberance gains hurt us. If we were perfectly rational creatures, someone would have reported on the results of the Shiller research on the day it was published and every study rooted in Buy-and-Hold principles would have been updated immediately. That’s just not how humans operate. They need to ponder things and ask questions and so on before making such a big change. My aim is to get that process of reconsideration of first principles started.
The important thing is to open every site to honest posting re the research. Once we do that, we take the fraud element out of this. If someone says “I BELIEVE that 4 percent is always safe but I acknowledge that there are others who have other views and their views are supported by legitimate research,” that’s not fraud in my assessment. In that case, anyone who employs a 4 percent withdrawal in his retirement plan knows what he is getting into. So I don’t view that as fraud. If the person is not able to hear the message that valuations affect long-term returns because of abusive posting or criminal acts, that IS fraud and that’s obviously a very big deal. So that is my focus.
I have doubts whether we will ever get to a place where the CAPE value is always 17 or thereabouts. That would be the ideal. But I suspect that the Get Rich Quick/Buy-and-Hold/irrational exuberance stuff is too much a part of our human nature for it ever to go away entirely. That said, I believe that we can make big progress and that we are close to doing so. I think that we can get to a place where the CAPE stays within a range from 13 to 21. That’s not ideal but it’s a lot better than what we have seen in recent years (a range from 8 to 44). It’s a gentle roller-coaster ride. A gentle roller-coaster ride would leave us with a more stable stock market, a more stable economy and a more stable political system. I could live with that. It would leave us all richer than we could imagine being during the Buy-and-Hold/Get Rich Quick Era.
The one specific statement that I have made is that I am confident that we could get the number of investors who practice Valuation-Informed Indexing up from 10 percent of the population to 20 percent of the population within six months of opening every site to honest posting re the research. I think that will make a big difference. We won’t be seeing any more criminal behavior at that point. Perhaps some abusive stuff, but much less. Once we get to 20 percent, I think things will just continue moving in a positive direction. I can’t say how long it will take. But so long as you are making steady progress, you are obviously going to end up in a better place over time. It will be a very different feeling.
I don’t think we are going to get the CAPE down through education. I think it is going to take a price collapse, which of course translates into an economic collapse because of the huge loss in consumer buying power. At that point, we would be in our way to a CAPE value of 8 and those who favor research-based strategies will be saying that the CAPE value should be higher. To not permit honest posting re the research at that time would put the survival of our economic system in jeopardy. So at that time I think you may see some people work up the courage to step forward and to stand up to you Goons. We’ll see.
The way to think about this matter is to see that it is like other huge advances in U.S. history. The civil rights movement was stalled in the late 1950s. Some people believed that that could never change. However, we achieved huge progress in the 1960s. We didn’t make it all the way to the finish line. But I can see big changes. The same thing is true with concern re the environment. It is shocking to remember that it wasn’t that long ago when concern for the environment just wasn’t a public policy concern. Attitudes toward smoking have changed dramatically. I remember a time when it would have been considered rude not to provide ashtrays for visitors in your living room.Today, nobody invites smoking in their living room.
Attitudes on these big issues don’t change in a straight-line, gradual way. Big changes are scary. So people avoid thinking about them. But, if the changes are important enough, eventually they do and then there can be a lot of positive movement achieved in a short amount of time. Getting stock investing right matters. So I think we are going to pull it off. I don’t believe that it will happen prior to the onset of the next Buy-and-Hold Crisis. But my sense is that we are positioned to achieve big steps forward at that time.
Wish us luck!
Rob
Hocomania.
Peer-reviewed research.
Rob
Rob’s interpretation of what is peer reviewed research is full of Hocomania.
What’s your interpretation? Do you think irrational exuberance is a good thing? How should we combat it, in your assessment?
Rob